The recent volatility in Chinese tech giants has provided interesting trading opportunities. The internet giants are highly exposed to regulatory scrutiny, but could there be light ahead of the tunnel?
Alternatively, domestic next-gen high-tech companies enabling China to achieve its strategic goals may also do well, and perhaps be the canary in the coalmine.
Traders in the Invesco Golden Dragon China ETF (ticker: PGJ) or KraneShares CSI China Internet ETF (ticker: KWEB) saw extremely volatile moves as some investors gave up on Chinese assets, and those same stocks saw a rapid reversal after China stepped in with comforting words for financial markets.
Major policy adjustment
China’s tech crackdown put a sharp dent in economic growth. Giants from Alibaba to Tencent have announced waves of layoffs that could potentially impact up to 15% of their workers.
With the war in Ukraine and the tighter financial conditions, Chinese internet giants suffered their worst market rout since 2009, with unprecedented volatility. Finally, the Vice-Premier on the 16th of March called on regulators to adopt a “standardised, transparent and predictable” approach in overseeing China’s internet giants, leading to a sharp bounce, though indices remain far in red year-to-date.
Interestingly, those periods of extreme volatility, in retrospect, have been attractive long-term buying opportunities.
Backdrop set to improve for tech giants
After significant hurdles, there are signs that the backdrop is improving for Chinese internet giants.
- The government vowed market-friendly policies
- China’s tech hub eases Covid curbs
- Fiscal and monetary policies could become more accommodative
- Valuations have come down significantly
- Investor sentiment is extremely weak
- Share buybacks: Many of the tech giants have large cash piles and some giants such as Alibaba and Xiaomi have began accelerating stock buybacks.
- Risk of US delisting, not a game-changer: China reported positive progress in talks with the US. Many Chinese companies have a double listing in Hong Kong.
Under the radar local tech companies
As the second-largest economy, China is seen as a place of growth opportunities. The government’s key objective is to sustain economic growth because it drives the nation’s development and helps it achieve other key goals, often referred to as “common prosperity”. There is also the “Made in China 2025”, which is a national strategic plan to further develop the Chinese manufacturing sector in 10 key industries, boosting China’s high-tech capabilities.
Giant internet services companies are the most affected by regulation as they touch on consumers’ data, privacy, gaming, and other sensitive areas.
On the other hand, smaller high-tech players are likely better positioned, due to their alignment with the government’s goals. For that reason, medium-size leaders are more likely on the receiving end of the government support (subsidies etc), while mega-cap players are more likely to continue to attract government scrutiny (fines, regulations etc).
Where to find those smaller domestic-focused high-tech firms?
The Shanghai Stock Exchange (SSE) Science and Technology Innovation Board 50 Index (STAR Market) offers exposure to those companies poised to be China’s future leaders across industries that could represent the growth engine of China for decades to come.
It includes companies from industries such as new-generation information technology, biomedicine (15%), new energy, and environmental protection.
It is possible to gain exposure to this market through the US-listed ETF: KraneShares SSE STAR Market 50 Index ETF (ticker: KSTR).
In our view, these companies could be more shielded from government scrutiny and could offer an interesting thematic long-term exposure to Chinese tech.
Since its beginnings in mid-2019, the STAR Market has become one of the largest IPO markets globally and a listing venue for prominent Chinese unicorns.
There are certainly opportunities in China tech and the backdrop is improving after the government stepped in to reassure financial markets. History suggests that the current environment with extreme volatility presents attractive entry points for the medium term. Next-gen high-tech companies on the STAR market may also offer a safer exposure to Chinese tech as they play to the State’s tune and are more likely to receive favourable terms from the government, as they fit into the State’s strategic goals.